Although France is generally regarded as one of Europe's stronger economies, the loss of its AAA rating would be devastating to European efforts to build a firewall that would prevent contagion from spreading through the EU banking system.

Italian borrowers owe French banks some $366 billion. That's on top of the $53.9 billion Greek borrowers of them.

Even though Italian PM Mario Monti is doing all he can to get his country's debt under control, the possibility that French banks might have to write down some of their Italian assets is looking increasingly likely.

Meaning the French government could have trouble backing up its massive banks.

French banks will have to raise $7.324 billion to meet the 9% capital requirement stipulated by the European Banking Authority. However, funding stresses are mounting on French banks as investors worry about bank exposures to PIIGS debt, and some banks could face difficulties obtaining necessary funds.

This would probably put further strain on France's already significant debt burden, as the country will probably not be able to access more funding from the eurozone rescue fund, the European Financial Stability Facility.

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Moody's announced in October that it is scrutinizing France's growth prospects.

The deterioration in debt metrics and the potential for further contingent liabilities to emerge are exerting pressure on the stable outlook of the government's Aaa debt rating. Moody's notes that the French government now has less room for maneuver in terms if stretching its balance sheet than it had in 2008. France's continued commitment to implementing the necessary economic and fiscal reform measures as well as visible progress in achieving the targeted sustainability improvements will be important for the stable outlook to be maintained.

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Those fears grew when Standard & Poor's threatened a two-notch downgrade of French sovereign debt

Now that the EU summit is over and leaders appeared to make little progress towards a eurozone endgame, investors are worried that we could see a downgrade any day now.

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And if France's rating goes down, EU rescue funds are sure to follow.

The French government's AAA rating is closely tied with its obligations to banks and the EFSF. Since France is responsible for 20.4% of the eurozone's revenues, downgrading the euro rescue fund "would be a pretty mechanical move," according to S&P's Moritz Kraemer, who spoke in a conference call after the downgrade watch announcement last week.

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A French downgrade would have dire consequences for the rest of the eurozone.

While Sarkozy has said that a downgrade would not pose an "insurmountable" obstacle to fixing the euro crisis, it would make the EFSF a far less effective instrument as its funds would no longer be "risk-free." This would elevate the urgency of a crisis fix—for better or for worse.

Challenges to the power of the EFSF (and subsequent European Stability Mechanism) could make it impossible for EU leaders to construct any kind of firewall around the PIIGS to prevent contagion from raging through the banking system.

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At the moment...

French borrowing costs rose at its first debt auction of the year, amid chatter of an impending downgrade, but average borrowing costs remain in the lower range.

Unlike Italy and Spain, France is not part of the Securities Market Programme—the plan which allows the European Central Bank to mitigate rising bond yields by purchasing debt on the secondary market.

If the yield on French debt and the cost of insuring rise, fears about rising borrowing costs could be self-fulfilling. The bigger the worry, the higher the cost of French borrowing, which will generate even more fear in the markets.